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Debt can burn start-up workers into recession

SAN FRANCISCO — Last year, Bolt Financial, a payments start-up, rolled out a new program for its employees. He had stock options in the company, some worth millions of dollars on paper, but could not touch that money until Bolt sold or went public. So Bolt began giving them loans – some reaching hundreds of thousands of dollars against the value of his stock.

In May, Bolt laid off 200 employees. It stipulated a 90-day period for those who had taken a loan to pay back the money. The company tried to help them explore repayment options, said a person with knowledge of the situation, who spoke anonymously because the person was not authorized to speak publicly.

Bolt’s program was the most extreme example of a growing ecosystem of loans to workers at privately held tech start-ups. In recent years, companies such as Quid and Sekfi have emerged to offer loans or other forms of financing to start-up employees, using the value of their private company shares as collateral. These providers estimate that start-up employees around the world have at least $1 trillion in equity to lend.

But as the start-up economy is now battered by economic uncertainty, rising inflation and rising interest rates, Bolt’s position serves as a warning about the uncertainty of these loans. While most of them are structured to be forgiven if a start-up fails, employees may still face a tax bill because loan forgiveness is treated as taxable income. And in situations like BOLT, paying off loans at short notice can be difficult.

“No one is thinking about what happens when things go down,” said Rick Heitzman, an investor at Firstmark Capital. “Everyone is only thinking about the upside.”

The proliferation of these loans has ignited a debate in Silicon Valley. Supporters said the loans were necessary for employees to participate in the tech’s wealth-creation engine. But critics said the loans posed unnecessary risk in an already risky industry and were reminiscent of the dot-com era of the early 2000s, when many tech workers were badly burned by loans related to their stock options. Were.

Ted Wang, a former start-up lawyer and an investor at Cowboy Ventures, was so concerned with the loans that he published a blog post “Playing With Fire” in 2014, advising against them for most people. Mr. Wang said he got a fresh round of calls about loans when the market was hot and always felt obliged to explain the risks.

“I’ve seen it go wrong, wrong, wrong,” he wrote in his blog post.

Start-up loans usually stem from the way workers are paid. As part of their compensation, most employees of privately held tech companies receive stock options. To own the stock, the options must eventually be exercised, or purchased at a set price. Once someone owns the shares, they usually cannot redeem them until the start-up goes public or is sold.

That’s where loans and other financing options come in. Start-up stock is used as collateral for these cash advances. Loans vary in structure, but most providers charge interest and a percentage of the worker’s stock when the company sells or goes public. Some are structured as contracts or investments. Unlike the loans offered by Bolt, most are referred to as “non-course” loans, meaning that employees are not on the hook to repay them if their stock loses its value.

This lending industry has grown rapidly in recent years. Many providers were created in the mid-2010s as hot start-ups such as Uber and Airbnb put off initial public offerings of stocks until they could hit a private market valuation in the billions of dollars.

This meant that many of his workers, bound by “golden handcuffs,” were unable to quit their jobs because their stock options had become so valuable that they could no longer pay taxes based on the current market value. Others grew tired of sitting on options while waiting for their companies to go public.

The loan gives start-up employees cash to use in the meantime, including money to cover the cost of buying their stock options. Still, many technical workers don’t always understand the intricacies of equity compensation.

“We work with supersmart Stanford computer science AI graduates, but no one explains it to them,” said Oren Barzilai, CEO EquityBee, a site that helps start-up workers find investors for their stocks.

A provider of financing and other services, Secfi has now issued $700 million in cash financing to start-up workers since its launch in 2017. Quid has issued hundreds of millions of loans and other financing to hundreds of people since 2016. Its latest $320 million fund is backed by institutions including Oaktree Capital Management, and it charges those who take out loans plus principal fees and interest.

So far, less than 2 percent of Quid’s debt has remained underwater, meaning the stock’s market value has fallen below debt, said company founder Josh Berman. Secfi said 35 percent of its loans and financing had been returned in full, and that it had a loss rate of 2 to 3 percent.

But Secfy’s chief executive, Frederic Mizenhardt, predicted that the next six to 12 months could be difficult for tech workers if their stock options decline in value in a recession, but they took out debt at a higher value.

“Employees may face a reckoning,” he said.

Such loans have become more popular in recent years, said JT Forbes, an accountant at Bogdan & Fresco that works with start-up employees. One big reason is that traditional banks will not lend against start-up equity. “There’s a lot of risk,” he said.

EquityB estimates that start-up employees pay $60 billion annually to exercise their stock options. For various reasons, including the inability to afford them, more than half of the options issued are never exercised, meaning workers forgo some of their compensation.

Mr. Forbes said they have to carefully explain the terms of such deals to their customers. “Contracts are very difficult to understand, and they don’t really play into math,” he said.

Some start-up workers regret taking loans. Grant Lee, 39, spent five years working at Optimizely, a software start-up that accumulated stock options worth millions. When he left the company in 2018, he had the option to buy or forfeit his options. He decided to use them, taking out a $400,000 loan to help with costs and taxes.

In 2020, Optimizely was acquired by Swedish software company Episerver for less than a previous private valuation of $1.1 billion. This means that stock options held by employees at higher valuations were worth less. For Mr. Lee, the value of his Optimizely stock fell below the value of the loan he took out. While his loan was forgiven, he still owed about $15,000 in taxes because the loan forgiveness counts as taxable income.

“I got nothing, and on top of that, I had to pay taxes to get nothing,” he said.

Other companies use loans to give their employees more flexibility. In May, Envoy, a San Francisco start-up that makes workplace software, used Quid to provide non-course loans to dozens of its employees so they could then get cash. Chief executive Larry Gadia said the messenger, which was recently valued at $1.4 billion, did not encourage or discourage people from taking out loans.

“If people believe in the company and want to double down on it and see how much better they can do, that’s a great option,” he said.

In a recession, loan terms can become more difficult. The IPO market is frozen, pushing potential payouts into the future, and the depressed stock market means that private start-up shares are probably priced lower than they were during boom times, especially in the past two years.

Quid is adding more underwriters to help it find a fair price for the start-up stock it lends to. “We are being more conservative than before,” Mr Berman said.

Bolt appears to be rare in that it has offered high-risk personal recourse loans to all of its employees. Bolt founder Ryan Breslow announces program congratulation flowers on twitter in February, writing that it showed “what we care about most about our employees.”

He said the company’s program was meant to help employees exercise their shares and cut taxes.

Bolt declined to comment on how many employees were affected by the loan payments. It gave employees the option to give their start-up shares back to the company to pay off their loans. Business Insider previously reported on the offer.

Mr Breslow, who stepped down as Bolt’s chief executive in February, did not respond to a request for comment on the layoffs and the loan.

In recent months, he has helped found Prysm, a non-course loan provider for start-up equity. In pitch material sent to investors, which was seen by The New York Times, Prism, which did not respond to a request for comment, advertised Mr. Breslow as its first customer. By borrowing against the value of his stock in Bolt, the presentation said, Mr. Breslow took out a $100 million loan.

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